Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has
ID: 2750462 • Letter: H
Question
Hastings Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capital structure consisting of 30% debt. Vandell's debt interest rate is 7.9%. Assume that the risk-free rate of interest is 6% and the market risk premium is 5%. Both Vandell and Hastings face a 40% tax rate.
Vandell's free cash flow (FCF0) is $2 million per year and is expected to grow at a constant rate of 5% a year; its beta is 1.40.
Hastings estimates that if it acquires Vandell, interest payments will be $1,500,000 per year for 3 years after which the current target capital structure of 30% debt will be maintained. Interest in the fourth year will be $1.462 million after which interest and the tax shield will grow at 5%. Synergies will cause the free cash flows to be $2.3 million, $2.9 million, $3.5 million, and then $3.85 million, after which the free cash flows will grow at a 5% rate. Assume Vandell now has $11.92 million in debt.
Indicate the range of possible prices that Hastings could bid for each share of Vandell common stock in an acquisition. Round your answers to the nearest cent. Do not round intermediate calculations.
The bid for each share should range between $ per share and $ per share.
Explanation / Answer
Vandell
Total Number of shares outstanding = 1 Million
Target Capital Structure = 30% debt
Debt interest rate = 7.9%
Beta = 1.40
Risk-free interest rate = 6%
Market risk premium = 5%
Tax rate = 40%
Current Free Cash Flow = $ 2 Million
Growth rate of free cash flow = 5% constant rate
Debt = $ 11.92 Million
Expected return on stock of Vandell as per CAPM
Expected return = risk free rate + Beta * Market risk premium
Expected return = 6% + 1.40 * 5% = 6% + 7% = 13%
Capital Structure of Vandell
Given Debt / Total Assets = 30%
Hence Equity /Total Assets = 1-0.30 = 0.70 or 70%
WACC of Vandell
Debt interest = 7.9%
Expected return on equity = 13%
Tax rate = 40%
WACC = 0.30 * 7.9% * (1-0.40) + 0.70 * 13% = 1.422% + 9.1% = 10.522% or 10.52% (rounded off)
FCF0 = $ 2 Million
Growth rate = 5%
Free Cash Flow next year FCF1 = $ 2 Million * 1.05 = $ 2.1 Million
Total Business Value = Free Cash Flow Next year FCF1 / (WACC - growth rate)
= $ 2.1 Million / (0.1052 – 0.05)
= $ 2.1 Million / 0.0552
= $ 40.22988 Million or $ 40.23 Million
Value of Equity = Total Business Value – Value of Equity = $ 40.23 Million - $ 11.92 Million
= $ 28.31 Million
Intrinsic Price of Vandell’s share = Value of Equity / No of Shares outstanding
= $ 28.31 Million / 1 Million = $ 28.31
year 1 2 3 4 Free cash flows 2.3 2.9 3.5 3.85 grwoth rate of free cash flows after year 4 5% Beta of Vandell 1.4 risk-free rate 6% Market risk premium 5% Expected return on equity =risk-free rate + beta * market risk premium = 5%+1.1*8% 13.00% Calculation of unlevered value of Vandell year 1 2 3 4 5 Free cash flows 2.3 2.9 3.5 3.85 4.0425 Cost of equity = 13% Present value of flows 1-4 2.035398 2.271125 2.425676 2.361277 Present value = FCF/(1+cost of Equity)^n Total Present value of flows yr1-4 9.093476 value of flows yr 4 in year 5/(cost of equity - growth rate) 50.53125 Present value of flows year 4 of flows/(1+cost of equity)^4 30.99176 Unlevered value of Vandell =Present value of cash flows for years 1-4 + present value of flows year 4 onwards 40.09 Calculation of interst tax-shield growth rate of interest and tax shiled after 4th year 5% Tax rate 40% year 1 2 3 4 5 interest expense 1.5 1.5 1.5 1.462 1.5351 Tax Shield = int *tax rate 0.6 0.6 0.6 0.5848 0.61404 Growth rate of interest and tax shield from 5th year onwards is 5% Calculation of per share value of Vandell Free Cash Flow = Operating cash flow + Interest Expense + Net Capex - Net change in WC - Tax shield on interest expense Other things being equal, Operating cash flow = Free cash flow + tax shield on interest expense -interest expense Given FCF year 1 2 3 4 5 FCF 2.3 2.9 3.5 3.85 4.0425 Interest 1.5 1.5 1.5 1.462 1.5351 Interest Tax Shield 0.6 0.6 0.6 0.5848 0.61404 EBIT * (1-Tax rate) or Op Cash Flow 1.4 2 2.6 2.9728 3.12144 weight of debt 30% Debt interest rate 7.90% After tax cost of debt 0.0474 or 4.74% Weight of Equity = 1- weight of debt =1-0.30 70% Cost of Equity 13.00% WACC = weight of debt * after tax cost of debt + weight of equity * cost of equity = 0.3 * 5.53% + 0.7*13% 10.5220% or 10.52% year 1 2 3 4 Operating Cash Flows 1.4 2 2.6 2.9728 Discount factor at 10.52% 0.904797 0.818658 0.74072 0.670201 = 1/(1+wacc)^n Present Value of Operating Flows 1.266716 1.637316 1.925871 1.992373 = ocf *discount factor Total present value of OCF for yr1-4 6.822276 =sum of present value of flows year1-4 OCF in year 5 3.12144 wacc 10.52% growth rate of flows 5% value of OCF after 4 years in year 4 = OCF in year 5/(wacc - growth rate) 56.52735 Present value of the value after 4 years = Value of OCF after 4 years in year 4 / (1+wacc)^4 = 38.99/(1+11.28%)^4 37.88468 Total Present Value = Total present value of OCF for year 1-4 + Present value of value after 4 years = 6.822276 + 37.88468 = 44.70696 Million Total number of shares outstanding 1 Million Value per share of Vandell = Total Present Value / Total number of shares outstanding $44.71 Hence Hastings can bid for Vandell from $ 28.31 to $ 44.71Related Questions
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